Tax Lawyer Blog

A Blog written by the Tax Attorneys for Individuals and Businesses

How do you make a great deal better? TAXES.

Date Published: Mar 2009 San Francisco Business Times

What is a great deal? It reminds me of the old legal maxim “You can name your price, if I can name the terms.” Most people focus on “how much do I have to pay” or “how much do I receive.” Negotiating the details of a transaction can make a tremendous difference in the amount of taxes incurred or saved. Not understanding the effect of the taxes can greatly affect the “true” price.

Why would taxes make a difference? It gets back to the terms. Most purchases or sales focus on price first and then terms: length of payment, interest, balloon payments, payment dates, inventory value, good will, and perhaps the details of what is being transferred, etc. So what about taxes? The more savvy the dealmaker the sweeter the deal and nothing is more sweet then little or no tax for my clients.

Over my 30 plus years of practicing tax law, I have negotiated for many clients, but one deal stands out to me as an example of the benefit of negotiating taxes. I was hired by one of my clients to negotiate the terms of a business that he was buying. The seller and his attorney were fixated on the price.

My client, the buyer, asked me to negotiate the terms that would affect his taxes, his general attorney had already negotiated the price and the general terms. When I arrived in the meeting the seller and his general attorney greeted me. The seller was a very determined person and before he could properly greet me, looked me in the eye and said, “I don’t care how many fancy lawyers are brought in, I’m not budging from the price.” I smiled and extended my hand and let him know I was not here to negotiate the price. He would have his price! I simply wanted to discuss the tax portion of the deal.

With that, he and his general attorney relaxed and we sat down to work on completing the deal.

The result of that meeting provided my client with all of the tax benefits, leaving the seller with all of the tax detriments. My client was very happy and the other side may never know how much the insisting on price and ignoring the tax effects really cost him. The seller received his price, but netted far less in his and account then if he had lowered the price and kept some of the tax benefits.

This concept works in so many aspects of business and should be considered before any negotiations begin. Use the tax code to your advantage and make your deal better.

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Article by Stephen Moskowitz, J.D., LLM., Senior Partner and co-author Anthony Diosdi, J.D., LLM. Senior Associate
Date Published: Feb 09 San Francisco Business Times

A limited liability company (LLC) combines certain advantages of corporations and partnerships. Like a corporation, a LLC and its members may enjoy asset protection benefits and personal liability protection from its creditors. For taxation purposes, the IRS classifies an LLC like a partnership and the income/losses realized by a partnership are distributed to the partners. It is important to understand the potential tax benefits of utilizing an LLC to real estate investors and individuals involved in real estate ventures.

LLCs benefit from the greater flexibility of the Subchapter K provisions of the Internal Revenue Code. Under Subchapter K, losses are deductible only to the extent of a partner’s basis of his partnership interest. A partner’s basis may be increased through his share of recourse liability or the economic risk of loss of an LLC liability to the extent he would bear the loss out of his non-partnership assets. The Internal Revenue Code uses the concept of “economic risk of loss” to classify a liability of an LLC.

An “economic risk of loss” could result in the allocation of a loss that can be used to offset ordinary income. The Income Tax Regulations employ a “doomsday” liquidation analysis to determine the allocation of such a loss. Basically, the Income Tax Regulations assume that all LLC assets are worthless. They also assume all the LLC liabilities are due and payable in full for no consideration. Finally, the Treasury Regulations question whether partners would be obligated to make a payment to a creditor or contribution to the LLC. In determining a partner’s payment obligations, the regulations take into account all statutory and contractual obligations related to the partnership liability, such as guarantees or obligations imposed by state law. For this purpose, guarantees, indemnifications, and other reimbursement arrangements are taken into account.

Applying the aforementioned rules to a typical venture, if the contractual obligations of the LLC could expose any of the partners to liability, (i.e. recourse liability such as a mortgage, contract with a developer, etc.), the LLC could make an allocation of a loss equal to amount of the potential exposure. This is the case even if the contractual agreement has not been satisfied or even if the partner is not individually liable for the agreement. This potentially is a significant tax benefit because it could result in the allocation of losses that could be utilized to offset the ordinary income of each partner such as wages, interest income, or dividends. It should be noted that the partner must recognize income tax liability in the amount of the losses allocated from the LLC when it dissolves or when the partner leaves the entity.

In order for you to be able claim any of the losses allocated to you from the LLC, a partner must satisfy the passive loss rules of the Internal Revenue Code. These rules were enacted to restrict taxpayers from using deductions and other losses generated from certain passive investment activities. The rule is applied on a partner-by-partner basis, not at the LLC level. Under the passive loss rules, a partner must “materially participate” in an LLC. These rules are beyond the scope of this article. However, under the passive loss rules, the partner must participates in the LLC more than 500 hours during the year of the loss allocation. It should be noted that further restrictions might apply to real estate professionals. The Internal Revenue Code does not impose any particular recordkeeping requirements to substantiate the passive loss rules. However, the Treasury Regulations do suggest that appointment books, calendars, and narrative statements may be used to establish the approximate hours devoted to an activity. As such, anyone considering utilizing the above-mentioned strategy should keep a detailed log of the hours they participate in the LLC. This may assist you to establish that you satisfy the passive loss rules in the event of an IRS audit. Given the complexities of Section K of the Internal Revenue Code, anyone considering utilizing an LLC for tax purposes should consult with a qualified tax attorney.

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